Economy

Fed Poised to Act, Watches Risks

The Federal Reserve is poised to take action as soon as this fall to help the lackluster economy if growth does not perk up. But as it considers whether to do so, most of the bank’s policymakers feel that a new round of bond-buying, so-called QE3, needs to be flexible enough to deal with future threats. There are two major ones on the horizon: The eurozone crisis, which could flare up at any time, and the U.S. fiscal cliff, which would deal a huge blow to the economy if policymakers fail to reach a deal to prevent a round of tax increases and spending cuts from kicking in at the end of the year.

There’s always uncertainty in economic predictions, but forecasting has become a particularly tough business these days. Minutes from the latest meeting of the Federal Open Market Committee, which sets policy for the central bank, noted an “unusually high level of uncertainty” attached to its members’ assessments of the economic outlook. The European crisis and threat of the fiscal cliff in the U.S. are a big reason why that’s the case.

So although many members of the FOMC indicated that they were prepared to act “fairly soon” if there wasn’t a “substantial and sustainable strengthening in the pace of the economic recovery” (which economists don’t expect in the near future), they noted the need to keep their options open—hinting at a feeling that they need to preserve ammunition to tackle problems that crop up down the line.

“Many participants indicated that any new purchase program should be sufficiently flexible to allow adjustments, as needed, in response to economic developments or to changes in the Committee's assessment of the efficacy and costs of the program,” said the minutes, released on Wednesday, which provided a summary of the July 31-Aug. 1 FOMC meeting.

Some Fed officials were concerned that QE3 could disrupt trading conditions in related markets; others worried that it would make it more difficult for the central bank to return its balance sheet to normal when it decides to step away from the highly accommodative policy of recent years. A few also noted concerns that an extended period of accommodation or another round of QE creates a risk to financial stability or could cause inflation to soar.

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The Fed entered the realm of unconventional monetary policy with two earlier rounds of QE. Fed Chairman Ben Bernanke has indicated that in this environment, the bank’s policymakers have an exceptionally wide range of views on whether and how to act—and that can slow the process of deciding to take the plunge.

Last month, Sen. Herb Kohl, D-Wis., asked Bernanke why the Fed “has been so slow” to address the unemployment problem over the past year. “Of course, we have taken a wide range of extraordinary actions to support the economy,” Bernanke replied, detailing the bank’s past actions--an iteration of his standard response to critics who ask why he’s waiting to act.

“The reason that there's any question is really, again, the range of views about efficacy, costs, and risk associated with these nonconventional measures,” he added.

The Fed has a dual mandate of promoting price stability and maximum employment. Inflation pressures have so far been contained, but unemployment is well above prerecession norms at 8.3 percent, prompting many to ask why the Fed isn’t doing more to bring it down. At the meeting, committee members weighed a variety of policy tools, including extending the forward guidance on the central bank’s key interest rates, doing another round of bond-buying, and cutting interest on reserves. But as the meeting concluded, the panel decided against acting.

At the end of this month, Bernanke will deliver a speech at the Fed’s annual meeting in Jackson Hole, Wyo., that central-bank watchers will closely parse for clues that the bank’s "pro" action list is beginning to outweigh the "con" side. If the August jobs report, released on Sept. 7, is poor or even simply not great, that, too, will be taken as a sign that the Fed is likely to act this fall.